What to Do if You Owe Taxes But Can’t Pay
Facing a large tax bill can be daunting, especially given you have a specific time limit for paying that bill to avoid incurring penalties and interest. However, if you owe taxes and can’t pay, all is not lost. There are options not only for making payments over time but also for getting the funds you need to satisfy the full amount of your tax debt by the filing deadline.
Steps to take if you owe taxes and can’t pay
As tax day approaches and you struggle to come up with the money for your tax due, you may start to panic. However, there is no need to panic. You are not alone in experiencing financial hardship, and the Internal Revenue Service provides a path forward so you can pay your income tax in full.
Pay as much as you can by the filing deadline
The first step is to file your tax return on time by the filing deadline, and pay as much as you can toward your tax liability. The more you can pay upfront, the less you will have to pay in additional penalties and interest later. Whatever you do, make sure you submit your tax filing on time; otherwise, you’ll incur another penalty for failure to file a tax return.
Notify the IRS
If you cannot pay your tax bill when filing your tax return by the deadline, the next step is to talk with an IRS associate to see if you can receive additional time to pay in full. There are several options available through the IRS for delayed payments.
Full payment agreement
If you are unable to pay your tax bill in full, you may qualify for a full payment agreement giving you up to 120 days to pay your taxes. Although there is no fee for a full payment agreement, you will continue to accrue interest and penalties on your balance until it is paid in full. You can call 800-829-1040 (individuals) or 800-829-4933 (businesses) to determine your eligibility, or you can go online and fill out an Online Payment Agreement application. For certain taxpayers, it’s possible to qualify for a short-term payment option allowing up to 180 days to pay your tax bill.
Installment agreement
With an installment agreement, the IRS will set up a payment plan wherein you can make monthly payments over time. Payment options include a direct debit from your bank account, payroll deduction from your employer, check or money order payments, credit card payments, electronic funds transfer payments, phone or Internet payments, or making cash payments at a retail partner.
Unlike a full payment agreement, the IRS charges a fee when you enter an installment plan; however, the fee could be reduced or waived for low-income taxpayers if certain conditions are met.
To see if you qualify, you can call the phone numbers listed above or complete the Online Payment Agreement application mentioned above.
Partial payment installment agreement or offer in compromise
If an installment agreement won’t work for you, you have the option of proposing a partial payment installment agreement (PPIA) or an offer in compromise (OIC). In each instance, you and the IRS agree on payment for an amount less than your actual tax liability to settle your tax bill. For your offer to be considered, you must meet the following requirements first:
- Filed all tax returns
- Made all required estimated tax payments for the current tax year
- Made all required federal tax deposits for the current quarter if you own a business with employees
To see if you are eligible, use the Offer in Compromise Pre-qualifier tool on the IRS website.
NOTE: If you currently have an open bankruptcy proceeding, you are not eligible to enter into an OIC.
Temporarily delay collection
If you don’t have the funds to pay your tax bill because you need that money to pay your basic living expenses, you can ask the IRS to hold off on collecting your tax bill until you have the money to pay it. If they agree to your request, you still will accrue penalties and interest on your balance. In addition, the IRS may file a Notice of Federal Tax Lien against property you own, such as your home.
A Notice of Federal Tax Lien also may be filed in the public records, meaning your creditors will see the IRS has a claim against you for back taxes. It also may show up on your credit report. This lien will remain until your entire tax balance–including penalties, interest and recording fees—is paid in full or the IRS is no longer legally allowed to collect the tax. There are certain conditions wherein the IRS may withdraw the lien before your tax bill is paid in full; these are noted on the IRS website or can be discussed with a tax professional.
Whatever you do, do not ignore any IRS notice
If you receive an IRS notice regarding your tax liability, do not ignore it. If you do so, the IRS can, and likely will, start a collection action against you. Therefore, following the notice’s instructions to contact the IRS to discuss payment of your tax bill.
Payment options to pay your tax debt
If you don’t have cash on hand to make your tax payments, there are other options you may take advantage of to pay your tax bill. When considering one of these options, evaluate the cost of using each option to see if the associated fees and interest will be less than what you would pay in interest and penalties to the IRS. Otherwise, it may cost you more to use one of these options than it would to just pay the IRS under one of its payment options.
Use a credit card
If your tax bill is relatively low, using a credit card may provide a quick and easy way to pay your taxes. However, if the interest rate is high or you won’t be able to pay off the balance quickly, using a credit card could quickly become more expensive than paying the IRS through one of its payment options. Talk with the IRS, a certified public accountant (CPA) or tax expert to help you evaluate how much you would owe in penalties and interest within a specific timeframe—for instance, six months—and compare that to the amount you would pay in credit card interest. This will provide a picture of the most affordable payment plan for you.
Get a home equity loan
If your tax bill is more substantial, you may consider using some of the equity in your home to pay the amount due on your income tax return. Again, though, it’s important to compare the costs of getting a home equity loan to the amount of penalties and interest you will accrue on your tax bill to determine which option is best for you. Because a home equity loan is essentially a second mortgage on your home, you will have to pay closing costs and fees on the home equity loan, as well as a fixed interest rate on the loan amount.
You also will need to confirm you have enough equity in your home to qualify for a home equity loan balance sufficient to cover your tax bill. In general, lenders will loan up to 85% of your home equity.
Use a home equity line of credit
Also relying on your home equity, a home equity line of credit, or HELOC, works like a credit card. You will be approved for a maximum balance, which you can draw against like a credit card, and you will be charged interest on the borrowed amount. Like a home equity loan, lenders typically will approve a HELOC for up to 85% of your home equity.
Unlike a home equity loan, which you repay with fixed payments over a specific length of time, on a HELOC you can make interest-only payments during the HELOC’s draw period—the time you are allowed to withdraw funds against the HELOC limit. Once the draw period ends, you will have to start paying both interest and principal on the balance due. These payments may fluctuate because the interest rate is not fixed, which can make it more difficult to determine payments in advance.
Get a personal loan
It’s possible to talk with a bank or credit union to obtain an unsecured personal loan to pay your back taxes. With this loan, you will pay off the balance during a specific loan term with a fixed interest rate, meaning your monthly payments will be the same throughout the entire repayment term. If considering a personal loan, look for one without any prepayment penalties that charge fees if you pay off the balance early.
Payment options to avoid
When trying to come up with the money to cover your unpaid taxes, you may start to consider using money from sources that are better left alone.
Retirement accounts
In looking at your retirement account, such an individual retirement account (IRA), 401(k) or simplified employee pension (SEP) IRA, it may seem tempting to take some of those funds to pay off your tax liability. However, If you are younger than 59 ½ years old, you not only would have to pay income taxes on any amount you withdraw, but you also may incur a 10% tax penalty. These amounts could drastically exceed the fees and penalties you would incur using other payment options. Plus, depending on the amount you withdraw, it could take far too much time to recover the amount you take out, especially with IRA limits on contributions.
Payday loans
Payday loans might be quick and easy to obtain, but that efficiency and availability comes at a high price. Payday loans typically come with much higher interest rates than personal loans or even credit cards, with many reaching more than 10 times the interest rate on personal loans or credit cards.
Car title loans
Like payday loans, car title loans come with very hefty interest rates that far exceed those on credit cards or personal loans. In addition, if you cannot pay off the loan as agreed, you could lose your car, which may be repossessed by the lender.
Savings accounts
Savings accounts typically serve two primary functions: The first is to pay for planned expenses such as buying a new car, paying for vacation or paying college tuition. The second is an emergency fund, which should be used to pay urgent, unexpected expenses such as car repairs or medical bills.
If your tax liability is minimum, paying your tax bill from your emergency fund could be a good choice. However, if it is more substantial, taking that money from your emergency fund could leave you without much-needed funds in the event of a true emergency. If you decide to use money from your regular savings account, you may have to postpone those planned expenses you have in mind for far longer than you want.
The bottom line
Facing a hefty tax bill can be daunting, especially if you don’t have the funds available to pay that bill at the end of tax season. However, there are options available to help you satisfy your tax liability. These include delayed payments to the IRS or using payment options such as credit cards or home equity loans.
Deciding which one works best for you and your financial needs depends on the amount of penalties and interest you accrue on your IRS tax bill versus how much you would pay in fees and interest for alternative payment options. Talking with an IRS associate, CPA or other tax expert can help you determine which choice is best for you.